by: Greg Silberman posted on: August 22, 2007 | about stocks: GLD / IAU    

Central Bankers poured $500 Billion Dollars (that’s Billion!) into the monetary system last week. The sheer quantity of intervention indicates an enormous monetary dislocation is taking place -- current gold prices remain firmly bid.

Wow! Last week's action left us breathless simply due to the sheer magnitude of money being forced down the markets throat. What we have here is a situation where risky fixed income investments ala CDO’s and sub prime mortgages have been written down to Zip Nudda!

Now obviously holders of these securities are not exactly writing them off their books, but what is happening is in an effort to fund redemptions the banks / hedge funds / pension funds or whoever holds these securities is finding they are UNMARKETABLE at exactly the time it really counts!

That left Central Bankers holding the bag to provide liquidity and help fund redemptions. This was necessary to prevent holders from selling other assets and causing a severe market rout.
An argument against gold stock investing is that they are just another asset class for hedge funds to dump when required to fund redemptions. So why buy Gold or Gold Stocks when they seemingly offer no protection against a market meltdown?

Of course it is a valid argument in the short-term (as we have all too painfully witnessed), but it fails to acknowledge that market participants understand that the central bank bailout will cause the money supply to rapidly increase. Gold has done a great job against an increasing money supply over the last 6 years.

In fact it is this tussle which has caused the AMEX Gold Bugs index to remain range bound for over 1 ½ years.

Chart 1- HUI finds strong support at 280; Current Gold Prices outperform Gold Stocks.

Now the game gets interesting!

Gold stocks had a terrible last couple of weeks which resulted in them testing major support (lower green line at 280).

Gold stocks versus the Dow continue to probe important resistance (red line). In a long-term Gold Bull market we would expect Gold Stocks to Outperform the Dow.

And finally Gold Stocks have underperformed against Gold Bullion and broken below support (bottom of chart – blue line). This is important because Gold stocks normally lead Gold bullion which portends to the possibility of more gold stock weakness.

Putting it all together we still think that the outlook for Gold Stocks remains exceptionally positive. In fact, the recent turmoil has made the fundamental case for Gold Stocks even stronger (although it’s hard to see when you get the wind knocked out of you). In particular, we recently mentioned in Prime Interest Rates and the market value of Gold that the safe haven status of Bonds is about to encounter substantial headwinds which should push investors to realize that Gold is the only asset of last resort.

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